Bernanke is fighting the wrong battle

by David Marsh

Mon 10 Oct 2011

Last week Fed chairman Ben Bernanke lectured the Chinese over alleged renminbi obduracy, claiming they were blocking worldwide recovery by refusing to allow the currency to revalue. The Chinese are easy targets. More difficult, but more worthwhile, would be to focus attention on the wider issue of world-wide currency distortions reflected in the under-valuation of the euro.

By going after the renminbi, Bernanke is maybe trying to boost his approval rating from US law-makers. But the Fed chairman has got the wrong adversary in his sights. On world markets the prize for the biggest under-valuations goes not to the renminbi, but to the two foremost reserve currencies, the dollar and the euro.

If Bernanke wished to bring about a currency realignment beneficial to the world economy, he’d push for a euro revaluation. This is a complicated task, but he could make a start by at least setting out an appropriate intellectual framework. It could take place only if one or several weaker components, starting with the Greeks, split off from the rest – providing the opportunity for other euro countries, led by the Germans, to forge a stronger, more durable and more compact monetary union.

Could it be that the Chinese currency is in fact starting to become over-valued? China has inflation of 6% compared with America’s 2%. Since the renminbi is appreciating by 3-4% a year, China is losing competitiveness against the US to the tune of at least 8% a year. According to a study from the Boston Consulting Group – quoted in last Friday’s Financial Times – rising Chinese labour costs and improving US productivity could cut sharply America’s trade deficit with Beijing over the rest of the decade.

If you’re searching for exchange rate distortions, figures from the Bank for International Settlements give some indication of the scale of the problem. They show that since monetary union in Europe started at end-1998 the Chinese currency has revalued by 10% in real terms against the rest of the world. The euro registered a real devaluation of 4%, the dollar a massive 18%. Discrepancies within monetary union – although diminishing somewhat during the past two years of crisis – have been still larger. According to the BIS data, the real value of the ‘German euro’ has fallen 10% since December 1998, while that of the ‘Greek euro’ has risen 6%. This has produced a corresponding competitiveness gap that can no longer be honed away through ‘internal devaluations’ – changes in relative costs and prices in Greece. Probably it will eventually have to be eradicated by Greece leaving the euro.

Germany and the other creditor nations of Europe would be better off with a 10% euro revaluation that would counter inflation via lower import prices, improve German consumer spending power through the terms of trade impact and raise productivity by promoting more efficient use of domestic industrial capital. Much political theatre in Washington centres on the renminbi. But the euro should really hold centre stage.